Chapter 7 Flashcards
What is the yield of a T-bill
(100-Price)/Price * 365/Term * 100
What is the current yield on a bond
current yield = (Annual cash flow)/Current market price * 100
What is the calculation for approximate YTM (AYTM)
AYTM=
((Interest income +/- Price change per compounding period)/(purchase price+Par value)/2) * 100
What is reinvestment risk
The rest that the coupons will earn a return that is lower than the rate that prevailed at the time the bound was purchased. only zero coupon bond has no reinvestment risk
What is the yield curve?
Relationship between yield and time to maturity. indicated the yield at a specified point in time for similar bonds that have same credit quality but different terms to maturity.
What is the expectation theory?
Attempts to explain shape of yield curve. Current long-term rates foreshadow future short-term rates.
Buying a single long term bond will yield the same as purchasing 2 short term bonds with a. combined Duration.
Two year interest rate must be equal to two successive and consecutive one year rates
What is liquidity preference theory
Attempts to explain shape of yield curve but doesn’t explain a down slope if it happens. The theory states that investors prefer short term bonds because they are more liquid and less price volatile. Therefore, the higher long term rates are explained by additional risk.
What is market segmentation theory?
Attemps to explain shape of yield curve. institutional player in the fixed income arena each concentrate efforts into a specific term sector. The yield curve represents the supply and demands which are primarily influence bed biggest players. Can explain All yield curves.
What is the relationship between maturity and changes in interest rates?
The longer term of the bond, the more volatile it will be to interest rate changes.
What is the relationship between coupons and changes in interest rates?
lower coupon bonds are more sensitive to changes in interest rates
How do we compare bonds with different coupon rates and different terms to maturity?
We use duration which is a measure of sensitivity of a bond’s price to interest rate changes. Approximate change in price for a 1% change in interest rate.
higher duration means higher price change for given yield, Therefore when you expect interest rates to rise, you should invest in bonds with low duration to protect portfolio, and opposite when interest rates are expected to decrease.
How do we compare bonds with different coupon rates and different terms to maturity?
We use duration which is a measure of sensitivity of a bond’s price to interest rate changes. Approximate change in price for a 1% change in interest rate.
higher duration means higher price change for given yield, Therefore when you expect interest rates to rise, you should invest in bonds with low duration to protect portfolio, and opposite when interest rates are expected to decrease.Wh
What is the sell side?
Concerned with trading investment products on their own accounts. Generally split into three roles
- Investmentt banker: help clients structure debts
- trader: trade securities in the second market
- sales representativeL market new and existing products, conduct research, provide market analysis, credit analysis and commentary
What is the buy side?
Concerned with asset management and typically engage in buying and holding of securities on behalf of institutional clients such as mutual funds, insurance companies and pensions. Includes portfolio managers and traders.
What is the role of inter-dealer brokers?
Act as agents, bring together institutional buys and sellers in matching trades. They perform price discovery which refers to determining the correct price by studying demand/supply. Main advantage is that it provide anonymity.
